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Wednesday, October 20, 2004

Whimper or Bang? Central Bank Economics

Over at Bop-news Stirling has been writing recently of "Japanification" and why this is the "plan" of the Establishment (that's "The Man" to you) for the future of the US economy.

For this to work we have to be at Japanification - namely that the future is going to be forced to save - not by privatization of social security. We already have done that in the form of housing. You don't save, whoever is going to buy your overpriced house will be forced to save.

But for this to work, as in Japan, all retirement has to be dropped into a form which is purely internal. That is, we have to force people to sink their retirements into local Bushbuck only assets. Like say, the mortgage market. Only if there is an endless supply of Bushbuck forced dollars to feed the forced market will this work. In short, sooner or later, sooner from the look of it, we will have to have the rivetization of social security - it has to be bolted in place to, as Japan's savings accounts are - prop up the dollar and soak up any glutted dollars that foreigners dump. Remember, it isn't the total number of dollars that matters, it is the dollars in circulation.

In short, the society is about to go into a lock down, where the young are going to be serfs to the old, being forced to marry later, raise children later, and consequently we are going to go down the road of Japan and have bigger and bigger incentives to breed. The "middle class tax cut" that everyone is talking about is the "child credit". We aren't helping the middle class, we are helping the breeding class. Japan has to do this too by the way, they are a decade farther down the road than we are, but we will catch up.

I am appreciative of Stirling's body of work and there is no doubt that many offshoring proponents would like this to be the outcome that occurs but there are reasons why it can't and won't happen. Let us review them.

First while offshorers are always touting the "new economy" it's clear we're still stuck with a petro-economy. Information is only worth what you can turn around use it to purchase fossil fuel with. The simple fact is that oil is holding above $53 bbl currently and that even with higher prices China has an estimated 8-10% growth in demand next year for crude.

The head of Asia’s biggest oil refiner, China’s Sinopec Corp., predicted on Tuesday that domestic demand in the world’s second-biggest oil consumer would moderate in 2005.

Chinese oil demand this year is up about 15 percent, but consumption is expected to ease as the government moves to prevent the economy from overheating.

The reason why prices on crude are floating up is the very real and practical expectation that even if Iraq's oil were to miraculously come back online, that it can't keep up with demand growth.

Proponents of offshoring often point to jobs imported to the USA from Europe as an example of offshoring "working" or being a "two-way street". This just covers up the real facts. To see why we need to discuss what happened in Japan in the original Japanification scenario.

Japan thanks to puchases of US debt putting leverage on its currency, the yen, was able to advance a way of imports to the United States that penetrated key market share levels in various sectors. It was followed by the various Asian "Tiger" export-based economies that attempted to emulate it. By issuing a great deal of debt Reagan was creating the opportunity for Volcker and Greenspan to lower interest rates, which they did, and in flooding the market with dollars brought the commodity price of oil down. This lowering of interest rates then created a boom in the US economy - but at the price of increased debt.

For Japan the essential trade was to leverage their currency against the US, export like crazy to America, and then turn around and buy oil with these US dollars.

Japanification happened because in order to push down the yen compared to the dollar and enhance its export prospects, the BOJ pursued a profligate monetary policy. This huge amount of liquidity flowing through the system created all sorts of speculation, asset bubbles, price inflation, and corruption. Eventually the price-bidding of major asset classes became a pyramid scheme, going upwards in a classic bubble on pure momentum buying. At some point it had to stop, and it did once the scheme collapsed.

At that point the BOJ had a huge problem. On one hand it had large amounts of liquidity that it had to evaporate to correct the system. On the other hand it had a collapsing asset market that couldn't absorb that liquidity and in fact was shedding it. Finally it was faced with a recession that it wanted to solve by injecting some new money, and all the while it still had the need to continue pushing down the yen to the dollar in order to continue exporting to the USA and buying oil with the dollar proceeds.

The problem was solved by the BOJ simply lowering the interest rates to zero and creating a liquidity trap scenario. As prices fell on assets, this introduced deflation and people had an incentive to save. In Japan, saving is a strong ethic. They also have vaarious institutions that enable saving. For instance the Japanese Postal System allows the Japanese to deposit on guarantee an unlimited amount of cash. As the economy tightened, the Japanese collectively began conserving more.

This allowed the BOJ to turn the individual Japanese savings accounts into a huge liquidity sink. All the money that was being set free into the system, both from asset liquidation and further BOJ liquidity injections from monetary policy could have a large part absorbed by the Japanese savers. In addition the BOJ encouraged banks to continue lending to corrupt and money losing institutions. This is counter-intuitive but the idea is that just as a profitable company can make money, that unprofitable one propped up by continuing credit can destroy value and act as a monetary black hole indefinitely. No matter how much money you lose on that company, you can always lose more.

By encouraging banks to not close bad loans, the BOJ was able to use non-performing assets in order to anchor the monetary sink. The BOJ could throw more money at companies, confident that they would either lose it or the difference would be soaked up by citizen savers.

Of course the reality of a nation of citizens saving and not spending and riddled with corrupt unprofitable companies is not one of prosperity and growth, but of decay arrested only by constant infusions of credit.

During the boom era, the fact that prices were rising were accepted because you could expect to get even more money as it came barelling down the pipeline. If prices rose a yen today if you got two yen tomorrow you were happy. However this kind of inflationary growth could not be forever sustained. The Japanification scenario allowed the BOJ to both continue a net positive liquidity inflow from monetary policy while maintaining a net negative economic liquidity. That is the BOJ needed to continuing putting two yen in today just so long as the economy hemmoraged three yen tomorrow.

This meant that new or younger entrants to the economic system were penalized. The older participants, having had a chance to build up their asset values and economic opportunities during the inflationary growth period were okay because they had saved value and were moving into an era of lower and lower prices. The new or younger participants struggled because having not yet become established, their cost structure dictated that they not save but spend in order to accumulate enough economic capital to make saving a net benefit. The young are not in the business of saving for the future. They are in the business of spending - spending time and money - to make themselves more valuable in the future so that they can take that higher income and then save.

The fact that deflation or economic liquidity hemmoraging had become the defacto official policy of the BOJ meant that they had no pricing power - because the goods and services being sold were the income that the young would have in turn needed to turn around and trade/sell/spend again until they were established themselves.

In an inflationary environment if you buy high, since prices are going higher you can turn around and sell even higher. And it goes around and around with each step someone taking a cut of the difference. In a deflationary environment the reverse occurs, and it is hard to build up capital because each time you trade a good or service the price environment is spirally lower so you take a small cut each time. This means that the net economic growth is the actual GDP minus the deflationary trend. In an inflationary environment without a constant growth of commodities or even higher monetary influx you will lose purchasing power, but in a deflationary environment you will lose pricing power.

For the average person to lose pricing power means that they have to work more for less or take a crappier job.

This then is the future that offshoring proponents would offer us when they remark that oh yes we are now getting jobs coming to us from Europe. Their plan, such as it is, is to continue the petro-economy debt trade but only to switch it over. A necessity of course to the money supply expansion is the influx of more commodities - which is why Iraq oil needed to be online.

The plan then was to allow European jobs to be shipped stateside, making us the Japan and Europe the new high rent capital flight/asset stripping/job offshoring center. There is every reason to think that the other countries in the world will succeed in switching from exporting to the USA to exporting to Europe but unfortunately it probably won't work as well here.

The simple reason why is that for the Japanification scenario to work here in the USA the USA would need to bring in oil using Euros. As the USA brings in more and more oil using Euros this will create immense pressure for oil to be priced in Euros. This is demonstrated to be occuring already as the dollar is declining over time against the Euro.

At the point that oil begins being priced in Euros then other countries will have much less incentive to export to us preferentially and to buy our debt. At that point the USA will because of its debt, the rise in debt service in the Federal Budget because of the lowered demand for debt being translated into higher interest rates, and the collapse of the dollar against other currencies - this would prove a sharp economic shock. It would be a period of high interest rates and high inflation in basic prices - the same imported goods that are cheap now would be very expensive then.

Even if this were not true the US Banking system hasa a stronger bankruptcy and creditor system than Japan, as well as more transparent capital markets. Normally you would think of this as an advantage but it effectively means that it is much more difficult in order to continue floating bad companies with increased credit-lines to non-performing loans. The markets here would likely punish such arrangements harshly compared to Japan.

In addition the US population is a consumer population with a declining savings rate and not an increasing one. Even if this were to adjust somewhat, in all liklihood the cultural pattern could not be changed sufficiently fast enough to generate the necessary consumer end of the liquidity trap. Americans like to spend what they get and unfortunately in a deflationary environment that adds up to adding pressure to the liquidity surge and not acting as a net brake to counter-balance central bank policy.

In the past, the Federal Reserve has for decades encouraged a low savings rate among Americans. This has been credited as a "virtuous circle" or "multiplier" effect that has made monetary and fiscal stimulus policy more effective. As soon as Americans get their hands on some money, they are likely to spend it. In the past this has boosted the economy, but in the future when the Federal Reserve needs to increase its injection of liquidity for instance to buy into a Treasury market with sharply falling demand it will not act as a counter-balance but indeed an amplifier for inflationary effects.

This fundamental cultural difference of being a spending consumer rather than a saver between here and Japan while enhancing US growth in the past is likely to make the gradual deflationary scenario of Japanification unlikely as an achievable goal here.

So while Greenspan and Bernacke would readily acquiesce to such a policy if they could, from the evidence this is pretty clear, the underlying new supply of commodities, the smooth transition to another major currency purchasing oil, the cultural differences between the USA and Japan - all of these and more make it highly unlikely that the globalists will have their way in the end.

There is likely going to be a sharp correction rather than a "rivetized" solution.

The more relevant example is probably the Russian Ruble devaluation and the market crash of the nineties. All in all America in ten years is more likely to look like the Russia of the last decade than the Japan of the last decade. Of course America has a much more advanced economy than Russia had, which is why the fall when it comes will be all the more dramatic.

5 Comments:

Thanks for the post. I now understand why you don't think that Japanification is likely here, and I agree with you. What do you think that the likely scenario is?

The only thing stopping an immediate petro-currency switch to euros is the US military. Bushco hoped that the lesson of Iraq would be allow petro-euros and your government will be otherthrown. Saddam switched to euro pricing in 2002 the US invaded in 2003. This is the point where things stopped going according to Buschco's plans.

Iraq was not easy or cheap to occupy. However, even with the slow weakening of the American military in Iraq, I don't think that there are currently many leaders of oil exporting countries who are willing to risk the US intervention that a euro-switch would provoke. Let the military weaken more and some minds may be changed.

The US commitment to militarism also makes a Japanification scenario considerably less likely in America. The US does not need failing businesses and opaque banking regulation to absorb excess liquidity; we have the military. The military-industrial complex can absorb any excess liquidity that American tax payers want to throw at it. I see ever increasing militarization as a much more likely outcome than Japanification, based on the cultural mores of us Americans.

Having an enormous military makes it much more likely that we will take the military solution when it is presented. Whether the military solution works or not, is an entirely different question. The US deflating its way to more oil is alot less likely to occur than the US trying to militarily sieze the remaining oil supplies.

BTW: I have trouble posting comments in the morning. Blogger appears slow or unresponsive.

Re the young generation, they will play along only if a credible carrot is dangling in front of their nose. These days my impression is that giving them (us? I'm 30+) enough perspective/prospects becomes increasingly difficult. I have to refer to my long-ridden theme of the fall of Eastern-European "communism". People were discouraged by obvious bullshitting and breakdown of incentive & accountability structures so much that they wouldn't contribute anymore, which was one major reason for things to fall apart. The same can happen in the West. Am I missing something?

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